Definition: The producer price index
(PPI) is the first indicator of inflation each month. It is a measure of
wholesale prices at the producer level for consumer goods and capital equipment.
Unlike the CPI, it does not include services. It compares prices for approximately
3,450 commodities to a base period. Currently, the base period, which equals
100, is the average prices that existed in 1982.

Related Indicators:

Source: Department of Labor

Frequency: Monthly

Availability: Two to three weeks
following the reported month.

Direction: Procyclical as inflation
tends to go up in booms and fall during recessions.

Timing: Coincident indicator

Volatility: Medium/High

Likely Impact on Financial Markets:

Interest Rates:Larger-than-expected
quarterly increase in price inflaton or increasing trend is considered
inflationary; this will cause bond prices to drop and yields and interest
rates to rise.

Stock Prices: Higher than expected
price inflation is bearish on the stock market as higher inflation will
lead to higher interest rates.

Exchange Rates: High inflation
has an uncertain effect. It would lead to a depreciation as higher prices
mean lower competitiveness. Conversely, higher inflation causes higher
interest rates and a tighter monetary policy that leads to an appreciation.

Ability to affect markets: High if
there are large unexpected changes in inflation rates.

Analysis of the Indicator:High price inflation is bad news for the bond market. A weak % rate
of change of the price deflators is received favorably by bond investors;
a strong inflation report causes concern the Fed might need to intervene
and raise interest rates--a negative for the fixed income market.
The PPI categories and respective weightings are: Finished Consumer
Goods 40% ; Food 26%; Capital Equipment 25%; Energy
9%. The data covers three stages of production: finished goods, intermediate
goods (those that are paritially processed), and crude materials. The latter
two stages are important because they provide an early indication of price
changes in the pipeline and forewarn of rising prices. The PPI can be volatile.
It is best to use the six-month to one-year moving average. The bond market
reacts negatively to larger-than-expected increases in the PPI. Conversely,
drops in the index are viewed favorably by investors, pushing bond prices
up and yields down.